FBAH: Chapter 4, 5
SG: Chapter 11
TOPIC 1: BSP2701 GLOBAL ECONOMY: GDP
MEASUREMENT AND AD/AS MODEL
Zhang Xuyao
Asia Competitiveness Institute
LKY School Of Public Policy
Prepared by
Dr. Xu Le
NUS Business School
HOW DO ECONOMISTS MEASURE THE
ECONOMY’S OVERALL HEALTH?
•
•
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“Singapore slashed its full-year economic growth forecast on Tuesday (Aug 13, 2019)
as global conditions were seen worsening and data confirmed the slowest growth
rate in a decade amid mounting fears of recession in the city-state.”
https://www.todayonline.com/singapore/singapore-slashes-2019- gdp-growthforecast-after-sharp-q2-contraction
“The US economy grew by an annualized 2.1 percent in the second quarter of 2019,
beating market expectations of 1.8 percent and following a 3.1 percent expansion in
the previous three-month period, the advance estimate showed. Household
consumption and government spending increased at faster rates, while a slump in
exports and a smaller inventory build made a negative contribution to growth.”
https://tradingeconomics.com/united-states/gdp-growth
“China has revised its 2020 gross domestic product (GDP) growth to 2.2per cent
year on year, down from 2.3per cent previously, according to a notice from the
National Bureau of Statistics on Friday (17 Dec 2021).”
https://www.channelnewsasia.com/business/china-revises-2020-gdp-growth-downslightly-22per-cent-yy-stats-bureau-2385896
THE PERFORMANCE OF ECONOMY IN 2021
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Based on advance estimates, the Singapore economy grew by 6.5 per cent on a
year-on-year basis in the third quarter of 2021, moderating from the 15.2 per
cent growth in the previous quarter.
https://www.mti.gov.sg/Newsroom/Press-Releases/2021/10/Singapore-GDPGrew-by-6_5-Per-Cent-in-the-Third-Quarter-of-2021
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In contrast to Europe and Japan, U.S. GDP exceeded its pre-COVID level in the
third quarter of 2021 and may reach its pre-crisis trend in the fourth quarter. The
pace of recovery in Europe in the second and third quarters was still very
substantial; as a result, the GDP gap vis-à-vis the U.S.
https://www.brookings.edu/blog/up-front/2021/12/08/a-most-unusualrecovery-how-the-us-rebound-from-covid-differs-from-rest-of-g7/
MACROECONOMICS
•
Macroeconomics studies the behavior of aggregate economies and the impact
of policies on their performance:
 How the economy behaves over long periods of time? (Economic Growth)
 What determines economic fluctuations? (Business Cycles)
 What causes unemployment?
 What drives price changes? (inflation)
 What is the role for economic policy and the government? (monetary and fiscal polices)
 How does the domestic economy interact with the rest of the world?(international
linkages)
CIRCULAR FLOW OF RESOURCES & PRODUCTS
MEASURING THE FLOW OF INCOME & EXPENDITURE
GDP: THREE MEASUREMENT APPROACHES
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Gross Domestic Product (GDP) is the market value of the final goods and services
produced in a country during a given period of time. It can be measured by 3
equivalent ways:
income method [GDP=Wages + Rental+ Profit]
 Remuneration(wages, rental, and profit) received by owners of primary factors of
production (labor, land, and capital);
expenditure method [GDP=C + G + I + NX]
 the market value of Final goods and services consumed or used by the households,
government, investors for capital formation, and overseas consumers.
 Intermediate goods such as, an electronic component sold by company A to
company B, a manufacturer of laptop is excluded.
value-added by industry method [GDP=VAMFG+ VACON+ …+VASVC]
 The sum of factor payments (value-added) made by each of the industries of the
economy engaged in the production;
INCOME METHOD FOR MEASURING GDP
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GDP at factor cost can be measured by summing up the income received by the owners
of primary resources (Labor, Land, Capital):
Labor (Wages)
Land Owners (Rental)
Capital Owners and Entrepreneurs (Profit)
GDP at market price = GDP at factor cost + Net Indirect Taxes
GOS
EXPENDITURE METHOD FOR MEASURING GDP
(I)
VALUE-ADDED METHOD FOR MEASURING GDP
THREE GDP APPROACHES
MEASURING WELL-BEING:REAL GDP AND
NOMINAL GDP
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Nominal GDP values output in the current year using prices from the current year
 Nominal GDP is the current dollar value of production
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Real GDP values output in the current year using the prices from the base year
 The base year is a reference year that changes infrequently
 Real GDP measures the physical volume of production
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GDP Deflator = Nominal GDP/Real GDP
 This is measure of general price level
 Another measure of general price level is the Consumer Price Index (CPI)
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Real GDP is a flawed measure of well-being . . .
WHY SINGAPORE IS NOT AMONG THE
HAPPIEST COUNTRIES IN THE WORLD?
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Singapore’s GDP grows 3.5 percent in 2017. Salaries are expected to rise 3.9
percent this year. The stock market continues to close at new record highs. An en
bloc deal is closed every other week, the latest being the second-largest eve
recorded sale of Pacific Mansio at S$980 million
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Singaporeans have all the reasons to be happy. Still, Singapore ranks only 34th in
United Nation’s newly published 2018 World Happiness Report, after dropping
eight positions from the previous year.
https://www.propertysoul.com/2018/03/27/singapore-not-happiest-country/
GDP AND WELL-BEING
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GDP Does Not Value Leisure
 GDP places a value of zero on all leisure time
 Omission of the value of leisure time makes GDP seem smaller
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GDP omits services that are not traded in markets
 Household production
 Self-sufficient households and bartered goods and services
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Underground economy is unreported transactions, legal and illegal
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Environmental Pollution:
 Clean-up activities are included in GDP
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Resource Depletion:
 No adjustment is made for the decline in resource availability when mining or other
harvesting is done
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GDP does not capture the effects of income inequality
 Most would prefer living in a relatively equal society to one with a few wealthy and many
poor
DETERMINATION OF THE LEVEL OF GDP
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Classical Economists –economists after Adam Smith
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The classical macro model provides a basis to consider how the level of GDP is
determined in the long run.
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Generalization from Micro to Macro Markets
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Assumptions
 Perfect flexibility of prices & flexible wages
 Full employment; voluntary unemployment
 Say’s Law: Supply creates its own demand
 Money is predominantly for transaction purpose; helps to determine the general
price level.
AGGREGATE DEMAND AND SUPPLY
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AD is the total output demanded in an economy at a given price level. It is the
total amount of goods people want to buy.
•
AS is the short run aggregate supply curve. It shows the total output produced in
an economy at a given price level. Short run is the period of time over which
nominal factor costs (such as wages) don’t change.
AGGREGATE DEMAND COMPONENTS
Component
Example
Determinants
Remarks
1
Consumption(C)
Food, cars, haircuts
DPI; i/r; Wealth;
Confidence; Policy
DPI is
disposable
income, i/r is
interest rate
2
Investment (I)
Machine & Eqpt, Land
Income; i/r; Policy;
Business
confidence
Change in
inventory stock
is included as
well
3
Govt Spending
(G)
Office supplies, Pest
Control
Growth &
Development
strategies.
Transfer
payment and i/r
payments on
Govt debt are
excluded in GDP
4
Net Export(NX)
Foreign vacation
National Income
and Foreign
Income; Exchange
Rate; Trade Policy
Tourists
expenditure is
export;
Residents’ expd
overseas is
imports.
THE AGGREGATE DEMAND CURVE
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AD is downward sloping because:
 Decrease in prices causes planned consumption (C), planned investment (I) to
rise-(purchasing power & affordability have increased)
 Decrease in prices causes net exports to increase (real exchange rate; local
goods becomes cheaper)
 Decrease in prices causes real wealth to increase leading to higher consumption
and investment.
 Decrease in prices decrease demand of money or real money supply increases
lower interest rate encourage investment and consumption.
SHIFTS IN THE AD CURVE
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A rightward shift of AD –due to positive demand shocks include: improvement or
increase in:
 Consumer confidence
 Consumer wealth
 Business confidence
 Net exports
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Stabilization policies that will shift the AD curve to the right include:
 Expansionary Fiscal policies
 Increase in government purchase
 A decrease in taxes
 Expansionary Monetary policies
 Autonomous easing of monetary policy;
 increase in money supply.
THE AGGREGATE SUPPLY CURVE
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AS curve is upward sloping in the short run because:
 Higher price with higher output gives higher profit especially when inputs prices
relatively sticky.
 Contractual: long term wage and price contracts
 Long-term contracts reduce the cost of negotiations between buyers and
sellers
 Long-term contracts build in wage and price increases that build in current
expectations about inflation
In the long run, the AS curve is vertical at the potential output Y*. (Classical
Macro Model)
SHIFTS IN THE AS CURVE
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A change in aggregate supply is a shift of the aggregate supply curve
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An increase in aggregate supply is a rightward shift of the curve
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Two main causes of shift in AS:
 Supply shocks
 Stabilization policy
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The positive supply shocks that shift AS curve to the right (AS1 to AS2) include:
 Increase availability of resources and technology breakthrough;
 decrease in prices of inputs;
 a slump in energy prices.
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Other policy options to shift AS curve to the right:
 Tax incentives for saving & investment
 Human capital investment;
 Trade liberalization;
 Infrastructure development.
PUTTING THE AD AND AS TOGETHER
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Short Run Aggregate Demand
As an example the equation of the AD curve:
Y = 5,025 –0.25P
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Short Run Aggregate Supply
As an example the equation of the AS curve :
Y–5000 = 20000(P–100)
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AD-AS Diagram
 E is the point of long run macroeconomic equilibrium with output at potential
level of 5000 and general price level is 100.
BUSINESS CYCLES
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If an economy is operating all the time on the long run growth trend, there would
not be any business cycles.
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Business cycles arise due to deviations from the potential output.
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The deviations from potential output arise due to demand shocks and supply
shocks.
RECESSION AND STAGFLATION
THE OUTPUT GAP, PRICE LEVEL AND
UNEMPLOYMENT
RESTORING FULL EMPLOYMENT
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The Classical Economists believe in ‘Self-correcting mechanism’ the economy
adjust automatically to full employment equilibrium given price flexibility.
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The sequence from recession to full employment:
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Recession at F unemployment nominal wages AS curve will shift to the
right. Lower prices stimulate AD movement along curve re-establish
equilibrium with full employment at E.
INTERVENTION: POLICY OPTIONS
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The AD and AS curves not only help to illustrate the causes of biz cycles, they also
indicates the policy options that could be used to restore full employment equilibrium.
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Basically the government have 3 policy options:
 Shifting the AD curve: policies that stimulate or restraint total spending. Fiscal and
monetary policies are examples of such policies.
 Shifting the AS curve: policy levers that reduce costs of production or that will
stimulate more output for every given price level.
 Do Nothing: allow self adjusting mechanism to restore full employment equilibrium
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The classical approach to economic policy embraced the ‘do nothing’ perspectives;
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The Keynesian economists would generally prefer to shift the AD curve
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The supply-siders seek to shift the AS curves by the use of tax rate reduction, deregulation and other mechanism to increase the ability and willingness of people to
produce goods and services.
SUMMARY